Limited liability can be impaired where assets are moved between companies within the group before insolvency arises. This will simply overthrow claims made by employees or unsecured creditors. Assets of the company are used to pay off any debts owed, notwithstanding that other groups have usually derived a benefit. In this situation, creditors or employees generally have no alternative to payment. An inquisitive example is evident in Patrick Stevedores Operations No 2 v Maritime Union of Australia (1998), with the corporate veil possibly acting as a barrier to retaining entitlements.
Furthermore, although Salomon concentrates on the discrete entity of a company, situations arise where managers exploit corporations in a group as one single economic entity. This emerges from the shifting of assets between companies without proper account, whilst this comprehensive intermingling can create confusion in the case of insolvency. Determining which group comprises which assets is a disadvantage of limited liability, as creditors can only call against the companys assets in which they directly deal with. As a result, limited liability of corporate groups can be costly and complex, in situations of insolvency.
LIMITED LIABILITY
Advantages
Limited liability minimises risk by enabling a company to externalise costs upon creditors. This facilitates economic growth as there is no concern of losing funds outside of the amount originally invested. Shareholders are therefore protected, as they are not liable for any debts incurred by the company. Separation of ownership and control is facilitated, by diminishing the need for shareholders to monitor performance, as well as allowing shareholders passive membership in the company. This advantages shareholders in corporate groups, allowing them to diversify their shareholdings in an extensive number of companies, in turn diversifying wealth. Courts are therefore reluctant to undermine limited liability as it performs a key function in the growth of the economy.
Limited Liability in Corporate Groups
Commentators such as Blumberg and Muscat are of the opinion that there is no reason to assimilate corporate groups with the concept of limited liability. Limited liability creates an incentive to invest as the level of economic activity increases, whilst corporate groups allow for an efficient capital market due to a ready transferability of shares. In regards to ownership and control being separated, this advantage becomes weak in light of the group structure. Diversification is unimportant for those parent companies that are risk-neutral, therefore modifying the concept of limited liability will slightly reduce opportunities available to diversify risk. Arguments in favour of limited liability in corporate groups are strongest where there are financial losses.
Disadvantages
Applying limited liability principles to groups of related companies, is manifesting continual problems in corporate law. As a corporate group is organised in layers of companies “insulating each corporate tier of the group, this achieves layers of insulation for the parent corporation from liability for the obligations of its numerous subsidiaries.” This possesses potential problems as it allows the groups to externalise any costs associated with risky behaviour to be placed on the victims or the general public, instead of those directly responsible. The potential disadvantages of limited liability present an important position to ‘sidestep’ or modify the principle in corporate group situations.
REFORM
In Australia, the corporate veil-piercing doctrine is quite vague. Parent companies should not be exempt behind the veil of incorporation and should be responsible for those affected by their decisions and conduct. In order to deter this type of behaviour, the corporate veil should be pierced, imposing liability on parent companies for any conduct where a lack of care, diligence or good faith can be established, when dealing with their subsidiaries.
Attempts have been made through statute, under section 588V of The Corporations Act 2001 (Cth), which states that in defined circumstances, a holding company can be liable for insolvent trading performed by the subsidiary. In return, this may pierce the corporate veil where a company accords another company in the group, the capacity to continue trading after it has become insolvent. In like situations, companies instead might accumulate their debts before facing insolvency. Furthermore, the process of litigation is not a favourable option as it is quite rigid and time consuming, preventing compensation for victims of tortious conduct by companies with few assets. Therefore, existing statutory attempts to overcome problems associated with limited liability appear inadequate.
In limited circumstances, courts may intervene and pierce the corporate veil by looking behind corporate structures. Traditionally, courts have had a rigid outlook on the separate legal entity principle, with members of other corporate groups only being liable in certain circumstances. For instance, members can not be liable merely when the corporate structure is used to guarantee liability for ‘particular future activities of the group.’ Jenkinson J depicted that the courts are hesitant in piercing the veil unless fraud, sham, unfairness or agency plays a role. Due to the difficulty in establishing this, influential creditors and tort victims are prohibited access from other members in the group. It appears that reform would be fundamental to provide worthy claimants with greater accessibility to pierce the corporate veil.
Antunes and counsel assisting the James Hardie Inquiry have been major proponents of change in relation to corporate groups and their related concepts. Antunes argues that parent companies exercise control over subsidiaries through ‘interlocking directorships’, reaffirming that the parent corporation should be liable for management decisions taken under its own control. Where parent companies have not interfered with subsidiaries, they may take advantage of the limited liability concept. Reforms suggested by Hansmann and Kraakman favour unlimited liability for shareholders, however, this may lead to the ‘disaggregation of enterprises.’ Mendelson further argues that shareholders that hold capacity to control the company should be liable for an unlimited amount due to better access to company information and the opportunity to benefit from activity. Instead of being based on the ownership of shares, liability would be determined from the capacity for one to control.
Problems are created within these corporate group structures as tension arises through this intermingling of assets. The pooling of assets may displace this predicament, as the assets of members in insolvent corporate groups may be used to fulfil any debts owed by each member of the group. As administrative costs are high and the pool of funds available to creditors is relatively low, pooling would enable unsecured creditors from individual entities to obtain dividends from the total asset pool of the group. Court orders enforcing the implementation of pooling arrangements have faced significant uncertainty when groups become insolvent, therefore the need for reform is crucial.
Conclusion
Although limited liability in corporate groups has advantages, it is apparent that this concept is readily abused and reform is in order. Limited liability is enjoyed by corporate groups, although often places unsecured creditors, employees or tort victims in unfair situations. It has been argued by commentators that those with the capacity to control the insolvent company should be held liable for debts incurred. Limited liability in the corporate group setting has come with much altercation, as it allows an insolvent company very few assets for distribution to creditors, as well as placing tort victims in a disadvantageous position. Whilst there have been statutory attempts to solve these complications, it appears that reforms are essential in regards to pooling arrangements and piercing the corporate veil, in order for group structures to be effectively workable.
REFERENCE LIST
Articles/Journals
Helen Anderson, ‘Piercing the Veil on Corporate Groups in Australia: The case for Reform’, (2009) 33(2) Melbourne University Law Review 333-367
Phillip Blumberg, ‘Limited Liability and Corporate Groups’ (1986) 11 Journal of Corporate Law 573, 574
Groeme Dean & Frank Clarke, ‘Corporate Officers’ Views on Cross Guarantees and other proposals to “lift the corporate veil”’ (2005) 23 Company and Securities Law Journal 299
William Douglas and Carrol Shanks, “Insulation from Liability through Subsidiary Corporations” (1929) 39 Yale Law Journal 193
Peter Edmunson and James Mitchell, ‘Knowing Receipt in Corporate Group structures’ (2005) 23 Company and Securities Law Journal 515
Michael Gillooly (ed), The Law Relating to Corporate Groups (Federation Press, 1993), 1
Michael Gronow, ‘Insolvent Corporate Groups and their Employees’ (2003) 21 Company and Securities Law Journal 188
Henry Hansmann and Reinier Kraakman, “The Essential Role of Organizational Law” (2000) 110 Yale Law Journal 387
Jason Harris, ‘Corporate Group Insolvencies’ (2007) 15 Insolvency Law Journal 79.
Markowitz HM “Portfolio Selection” (1952) 7 Journal of Finance 77
Nina Mendelson, “A Control-based approach to shareholder liability for corporate torts” (2002) 102 Columbian Law Review 1203
Damien Murphy, ‘Holding Company Liability for Debts of Subsidiaries: Corporate Governance Implications’ (1998) Bond Law Review 14
James O’Donovan, ‘Corporate Insolvency’ (2006) 24 Company & Securities Law Journal 443
Christian Witting, ‘Modified Limited Liability’ (2009) 27 Company and Securities Law Journal 108
Statutes
Corporations Act 2001 (Cth)
Case Law
Adams v Cape Industries plc [1990] Ch 433
Briggs v James Hardie Co (1989) 16 NSWLR 549
Dennis Willcox v Federal Commissioner for Taxation 19 ATR 1122, 272
Patrick Stevedores Operations No 2 v Maritime Union of Australia (1998) 195 CLR 1
Salomon v A Salomon & Co [1897] AC 22
Walker v Wimbourne (1976) 137 CLR 1, Mason J at 7
Michael Gillooly (ed), The Law Relating to Corporate Groups (Federation Press, 1993), 1.
Corporations Act 2001 (Cth) s50.
Christian Witting, ‘Modified Limited Liability’ (2009) 27 Company and Securities Law Journal 108, 109.
Groeme Dean & Frank Clarke, ‘Corporate Officers’ Views on Cross Guarantees and other proposals to “lift the corporate veil”’ (2005) 23 Company and Securities Law Journal 299.
Christian Witting, above n 4.
Walker v Wimbourne (1976) 137 CLR 1, Mason J at 7.
James O’Donovan, ‘Corporate Insolvency’ (2006) 24 Company &Securities Law Journal 443
Christian Witting, above n 4.
Peter Edmunson and James Mitchell, ‘Knowing Receipt in Corporate Group structures’ (2005) 23 Company and Securities Law Journal 515.
Michael Gronow, ‘Insolvent Corporate Groups and their Employees’ (2003) 21 Company and Securities Law Journal 188.
Jason Harris, ‘Corporate Group Insolvencies’ (2007) 15 Insolvency Law Journal 79.
Markowitz HM “Portfolio Selection” (1952) 7 Journal of Finance 77.
William Douglas and Carrol Shanks, “Insulation from Liability through Subsidiary Corporations” (1929) 39 Yale Law Journal 193.
Christian Witting, above n 4, 115.
Damien Murphy, ‘Holding Company Liability for Debts of Subsidiaries: Corporate Governance Implications’ (1998) Bond Law Review 14.
Jason Harris, above n 15, 116.
Phillip Blumberg, ‘Limited Liability and Corporate Groups’ (1986) 11 Journal of Corporate Law 573, 574
Jason Harris, above n 15.
Helen Anderson, ‘Piercing the Veil on Corporate Groups in Australia: The case for Reform’, (2009) 33(2) Melbourne University Law Review 333-367.
Jason Harris, above n 15.
Michael Gronow, above n 12.
Adams v Cape Industries plc [1990] Ch 433.
Dennis Willcox v Federal Commissioner for Taxation 19 ATR 1122, 272.
Christian Witting, above n 4, 116.
Henry Hansmann and Reinier Kraakman, “The Essential Role of Organizational Law” (2000) 110 Yale Law Journal 387.
Christian Witting, above n 4, 119.
Nina Mendelson, “A Control-based approach to shareholder liability for corporate torts” (2002) 102 Columbian Law Review 1203.
Christian Witting, above n 4, 119.
Jason Harris, above n 15, 79.